Losing Operating Credit & Loan Subordination (Questions and Answers)

The recent drop in crop prices has put a financial squeeze on some Nebraska producers. What happens if you lose your operating credit? Dave Aiken, UNL agricultural law specialist, answers questions relating to losing operating credit and loan subordination.

SO WHAT HAPPENS IF A PRODUCER GETS THEIR OPERATING LOAN CUT OFF? Depends on whether or the lender moves into loan foreclosure. If that happens, you need to contact an attorney immediately.

WHAT HAPPENS IF THE LENDER DOES NOT FORECLOSE? Then the producer will try to find new operating credit from suppliers (seed dealer, fuel dealer, chemical dealer, etc.) or even from family members.

HOW DOES THAT WORK? The important point to realize is that the new creditors may not be protected on the new crop. So the producer may need to negotiate what is called a “subordination agreement” with the old lender.

PLEASE EXPLAIN THAT. On the operating loan, the producer buys their inputs and puts in the crop. The operating lender takes that new crop as collateral (or security) for the operating loan. After harvest the producer pays off the operating loan and the process repeats itself.

WHERE DOES LOAN SUBORDINATION COME IN? If the producer gets cut off for operating credit, the “old” operating lender will still likely have any new crop produced as collateral for the old, unpaid operating loan. So steps are needed to protect the new creditors.

CAN YOU GIVE US AN EXAMPLE? Yes–a 1985 Nebraska Supreme Court decision shows how this works. The operating lender cut off operating credit with an unpaid loan balance of over $100,000 but didn’t foreclose. The farmer’s brother-in-law loaned the farmer $46,000 to put in the next crop. The farmer, brother-in-law and the lender agreed that the lender would receive the first $20,000 from the new crop before the brother-in-law got paid. If this agreement had not been made, the brother-in-law would not have received anything from the new crop–the old lender would have gotten everything from the new crop.

HOW WOULD THIS WORK FOR INPUT SUPPLIERS? Same approach. The producer would have to negotiate to get the old operating lender to agree to share the proceeds from the new crop with the new operating creditors.

ARE SUBORDINATION AGREEMENTS EASY TO NEGOTIATE? No–in all likelihood there won’t be enough revenue from the new crop to pay everyone in full. So everyone–particularly the new creditors–should go into this with their eyes open.

HOW DO YOU MAKE THE OPERATING AGREEMENT? Be sure to get it in writing. I would work with an attorney.

WHERE CAN PRODUCERS GO TO FOR HELP WITH THESE ISSUES? Three main sources. First—Nebraska Farm Hotline–financial, legal and emotional counseling. Second--Nebraska Department of Agricultural ag solutions negotiations program–legal and financial counseling and farm credit mediation. Third–Nebraska Legal Aid–legal counseling and representation.

WHAT IS MEDIATION? A neutral third party–the mediator--tries to get parties to negotiate a compromise. Mediation be used to negotiate loan subordination agreements. Mediation has been used to avoid foreclosure and bankruptcy.

WHAT ABOUT FARM SERVICE AGENCY BORROWERS? FSA has a detailed, borrower-friendly process to deal with financial distress, including mediation.

Contact information for the farm hotline, ag mediation, and legal aid is below:
• Nebraska Farm Hotline 800-464-0258 (financial, legal and family counseling services and referrals)
• Farm Finance & Legal Assistance Clinics 800-464-0258 (free monthly clinics sponsored by Nebraska Department of Agriculture Farm Mediation Service dealing with debtor-creditor issues and farm credit mediation)
• Nebraska Farm Mediation Service 800-446-4071 (Nebraska Department of Agriculture program, assists agricultural borrowers and lenders resolve agricultural debt issues)

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